Monetary System And Its Diversity Example
If this divergence in optimal monetary policy stance increases, the strains on the system will grow. It now plays a central role in the management of balance of payments difficulties and international financial crises. Countries contribute funds to a pool through a quota system from which countries experiencing balance of payments problems can borrow money.
The financial crisis could have long-lasting effects on the composition and rate of global economic growth. 8 Since divergent growth and inflation prospects require different policy mixes, it is unlikely that monetary policy suitable for United States will be appropriate for most other countries. However, those countries with relatively fixed exchange rates and relatively open capital accounts are acting as if it is.
For these three primary reasons, and as a result of the 2008 global financial crises, some modern economists are calling for the return of the gold standard or a similar system. However, gold was trading at higher prices in foreign markets, so in 1971, the U.S. stopped selling gold to foreign investors who wanted to trade their U.S. dollars for gold. In 1973, the U.S. devalued the dollar, but circumstances forced a second devaluation only 2 weeks later. It was clear to everyone in finance and government that there simply was not enough gold to back the amount of currency needed to maintain economic growth. In 1974, President Ford repealed the prohibition on the public’s ability to own gold.
Much more importantly, however, the primacy of exchange rate policy hinders the effective use of monetary policy in response to macroeconomic shocks and is therefore a source of significant volatility in the economy. Speculative capital inflows need to be absorbed and thus reinforce the need for reserve accumulation. This, in turn, further restricts the room for manoeuvre, for instance in response to the import of inflationary pressures and the build-up of asset price bubbles. As a consequence, national wealth is increasingly badly diversified and returns to foreign exchange reserves and income on foreign assets become less and less attractive. At the same time, domestic financial markets are penalised, as the concomitant restrictions imposed by the central bank hinder financial development and lead to financial repression.
Exchange controls and import restrictions such as those employed by European nations during the early years of Bretton Woods, ceased to be an option after the restoration of current account convertibility in 1958 and the development of Eurodollars in the 1960s. This only left parity adjustments for removing disequilibrium which nations refused to do for fear of embarrassment – parity adjustments were a conspicuous sign of failure. The assertion is often made that monetary and price stability are what underpin macroeconomic stability. A relationship between monetary and financial stability also obtains even if its nature is more controversial. Under the classical gold standard, there was strong economic performance, no inflation, and stability in the foreign exchanges. Additionally, the classical gold standard appealed because, in keeping largely with the mood of the nineteenth century, it limited governments’ scope for action in monetary affairs.
Economic growth requires a proportionate increase in the money supply in order to avoid deflation that would paralyze business, but an increase in the quantity of money involves a simultaneous increase in debt. This way, economic actors run into danger of excessive indebtedness and bankruptcy. It is not necessary to say that overindebtedness causes serious problems to societies and individuals in the face of the ongoing debt crisis. It began as a debt crisis of private homeowners in the United States and then transformed into a debt crisis of commercial banks and insurance companies before being absorbed by national treasuries and so turned into a sovereign debt crisis.